Far From The Front In The War With Russia, Lviv Seeks To Evolve From Outsourcing Hub To Ukrainian Silicon Valley

LVIV, Ukraine -- Olena Kozlova's father was in the Soviet army, so the family moved around constantly before eventually settling in Lviv, in the far west of what would become, when she was 17 years old, an independent Ukraine. There she stayed, ultimately founding a software company as the city's IT industry began to blossom in the early 2000s.

Thanks to growing up near military bases, Kozlova recognized the sound of distant explosions before her train reached Kharkiv on February 24, 2022 -- the day Russia launched its large-scale invasion of Ukraine, sending troops in from three sides and bombarding targets nationwide with rockets and artillery before dawn.

A university town with a similarly thriving IT industry, Kharkiv, Ukraine's second-largest city, sits near the Russian border at the opposite end of the country from Lviv. Kozlova was headed there to open an office for the 10-odd workers for her company, PLVision, who called the city home.

"They didn't want to relocate. I asked them several times. I warned them. But they didn't want to move and I wanted to support them," Kozlova said.

That morning, she stopped in Poltava and called the employees left in Kharkiv, asking each of them, "Are you driving to Lviv?"

She herself headed home. Many people seeking to escape the Russian onslaught followed the same route. In the past 14 months, Lviv has likely taken in more Ukrainians than any other city in the world, with Mayor Andriy Sadoviy estimating that 150,000 who fled areas further east remained as of February.

Senior test engineer Dmytro Zazvonniy had worked at Sigma's Kharkiv office for seven years before coming to Lviv. Originally from Kramatorsk, a heavy industry hub in the Donbas, he'd gone to Kharkiv for university. His family followed him from their hometown when war broke out in the Donbas in 2014, so the outset of the full-scale invasion was, for him, laden with déjà vu.

The day of the invasion, he recalls waking up at 5 a.m. to light flooding into his apartment from windows that face the Russian border. "We realized everything quite quickly -- that it's just the same as it was in Kramatorsk," he said of the conversation in February 2022, when he and his brother decided to move everyone to Lviv.

Russia's full-scale invasion drew the world's eyes to many aspects of Ukrainian society. The massive and ultra-migratory IT industry that Ukraine had built up since the late '90s emerged as an unlikely hero, continuing to bring money into the country as bombings and blackouts roiled the country.

A lifeline to Western companies and their relatively massive budgets, IT outsourcing is a core financial artery linking Ukraine with the rest of the world. In 2022, those services accounted for $7.3 billion in exports -- recently surpassing metals and now behind only agriculture in terms of dollar amounts.

Overall exports dipped by 35 percent over the first year following the February 2022 invasion, while IT services rose. IT workers have proved much tougher for Russia to blockade than grain ships at port -- though the National Bank of Ukraine's latest data show a dip in the value of IT exports to just under $500 million per month following winter strikes on electrical infrastructure.

The industry and the tech talent that it produces have become a pillar of Ukraine's blueprints for economic recovery in a postwar world.

A Hitchhiker's Guide

These ambitions revolve around long-standing hubs, including Kyiv, Kharkiv and Odesa. However, no city has taken in more of the digital migrants than Lviv. Ukraine's seventh-largest city before the invasion, it has assumed the second spot, behind the much larger Kyiv, in most metrics of the tech industry.

A city where locals remind visitors that they were under the Hapsburgs and never the Romanovs, Lviv has been a haven from Russian influence and something of a wellspring of Ukrainian-language culture since the days of the tsars. The financial and cultural impact of the IT industry -- and its money -- are visible throughout the heart of Lviv, which resembles Vienna more than Moscow.

Lviv's Startup Depot keeps time alongside more traditional leaders in world tech investment.

Tech giant offices and newfangled coworking facilities dot the city of 700,000, penetrating the rings of Soviet-built apartment blocks that still provide cheaper housing on the outskirts of the city.

By virtue of concentration, conditions approximating peace, and the traditional dominance of the Ukrainian language, Lviv is set up as an ideal test bed for the country's postwar ambitions.

Post-Soviet Poster Child

"Me and my friends were the first in this generation that started to work just as the Soviet Union collapsed and PC computers just started to be popular in Ukraine," Yaroslav Lyubinets said.

Lyubinets and his fellow postgrads at Lviv Polytechnic Institute started SoftServe in the mid-1990s, working with 10 people in a makeshift office crammed into a two-room apartment, guided by a General Electric executive who'd come to Lviv to teach the fundamentals of Western business.

Today, Lyubinets is chairman of the board and SoftServe is the biggest IT outsourcer in Lviv, employing some 11,000 people throughout Ukraine and internationally.

Founded by SoftServe and fellow outsourcers ELEKS and N-IX between 2009 and 2011, Lviv IT Cluster is a major nexus in the web of local firms, universities and politicians. ELEKS founder Oleksiy Skrypnyk, for example, would eventually leave the firm to become a member of Ukraine's parliament in 2014.

Lviv Polytechnic University and neighboring Ukrainian Catholic University are core educational links, providing a pipeline of students like those Lyubinets recruited in SoftServe's early years.

New tech firms join the universities congregated around Striyskiy Park in the south of the city.

"Lviv IT Cluster is the strongest [of its kind] in Ukraine by far. The most active one -- I mean, one that really does things," said Ivan Petrenko, who runs a local venture fund.

The innovation park under construction in Lviv's southern university district encourages visitors and workers to "Live, work, learn, relax."

The problem, Petrenko says, is the cluster's enduring focus on outsourcing. It provides steady income but will not produce the next Grammarly or GitLab. The two Ukrainian-origin firms have become hometown heroes after "unicorning" -- getting investment valuing them at over $1 billion -- following moves to San Francisco.

"We always considered that we want to raise money outside, because for sure you can get more money if you're not a Ukrainian company. Especially if you are an American company," said Ross Khanas, a Lvivan who runs a team of seven writing software for managing coworking spaces. His firm, andcards, is one of the startlingly few in Lviv coding their own product, he says.

It's a widely acknowledged problem that remains the standard in Lviv, but it's one that many are trying to change.

"We are trying to evolve some and develop new projects and therefore, I think that we will be a hub and Silicon Valley for startups because until that period, we were just doing the work for somebody else." said Oleh Chuchman, who runs an outsourcing-staffing company called Ukrany.

New Money

More Lvivans are looking to channel investments into startups.

Petrenko, for example, runs Angel One Venture Fund, which launched in October with money from the Ukrainian Catholic University Fund aiming at early-stage startups, especially those connected to the university. The fund just made its first investment, to a $1 million seed round for Zeely, a mobile webpage-designer app.

A graduate of Lviv Polytechnic and a longtime ELEKS employee, Ivan Dmytrasevych is similarly trying to convert the IT world's money into proper local capital. While he runs UNameIT, an outsourcing company, he also built a coworking and startup accelerator facility in Lviv's north and manages Lviv Tech Angels, a fund that targets brand-new firms for which small investments make a big difference, but that are also relatively likely to go broke without paying any returns.

Lviv Tech Angels, however, has made no new investments since 2021, and is largely on hold. "Unfortunately, most [members] don't have plans to invest till the end of the year," Dmytrasevich wrote in a message.

SoftServe, Lyubinets said, was on the threshold of launching its own venture fund at the beginning of 2022. Similarly, the government's Ukrainian Startup Fund, which was a go-to source of seed investment for small firms, cut off almost all of its investments outside of military technology once Russia launched the invasion.

A physical manifestation of this freeze is Lviv Tech.City, a massive planned coworking campus in the same milieu as many of the universities and offices, looking out on Striyskiy Park. Only one building has opened, while the rest of construction remains frozen in time.

Construction on the projected innovation park has been frozen in time since the start of the war.

At the same time, a number of foreign investors like FF.VC's Blue & Yellow Heritage Fund and Ukrainian Phoenix Tech Fund have emerged, explicitly aiming to send money into Ukraine amid the risks of wartime. They have yet to make their first investments.

In this and in basically every other area, it is vividly apparent how tightly coiled the whole system is in anticipation of the end of the war -- which shows few signs of ending any time soon, as heavy fighting continues in the Donbas and Ukraine gears up for what could be a major counteroffensive this spring.

President Volodymyr Zelenskiy has made numerous public calls for investment in the IT sector. War is not the only thing standing in the way.

The nature of outsourcing is that products and potential rewards slip across borders into the hands of the contracting companies. This has primed the outsourcing companies to operate borderlessly.

Borders And Blockage

Sigma, for example, advertises itself as "a Swedish company of Ukrainian origin." The Swedish office has "maybe up to 10" employees, said Oksana Nazarkevych, head of Sigma's Lviv office. "Sweden is a very expensive country, so it's difficult to hire people that are, like, developers or something."

SoftServe's LinkedIn page puts its location as Austin, Texas. Kyiv-based EPAM, likely the largest IT outsourcer in the country, is part of a low-tax regulatory "sandbox" for tech in Belarus, whose government supports Russia's war against Ukraine.

Ukrainian companies serving foreign clients typically need to set up foreign entities to get bank accounts and maybe, one day, go public, while Ukraine's stock market remains anemic. Foreign entities also give clients the assurances of, say, U.S. courts.

"We know we're still one of the most corrupt countries in the world. We are just not talking about it too much because there's war," Petrenko said. "We try to balance it. Like, we know, OK, we have a problem. We have a bigger problem right now that we have to deal with."

An investigation publicized in February into major app maker MacPaw over recent property acquisitions had CEO Oleksandr Kosovan warning of "bureaucrats looking for a pretext, an occasion, and a means of squeezing Ukrainian business."

Particularly when it comes to transferring intellectual property -- which is ultimately what code is -- Ukraine's legal system is hapless.

Scattered registrations and international bank accounts also quickly open up various routes of tax avoidance. Keen to encourage the development of the IT industry, the Ukrainian government has spent the past 25 years turning a blind eye to the endemic business practice of registering IT employees as contractors rather than full-time employees. This lowers the required income tax from upwards of 40 percent to closer to 5 percent.

"If we're talking about a private company, I would say that 90 percent or 95 percent are contractors," Chuchman said.

Carrot And Stick

Post-Soviet economies are full of ad-hoc systems, but networks of undeclared workers and opaque banking scare Western investors off, as they make it harder to verify what a company is up to. Moreover, the war has the government hunting for untapped tax bases. And, as Ukraine's economy develops and integrates with the West, things are changing. But slowly.

In an office surrounded by posters of comic book heroes and sci-fi villains, Deputy Minister of Digital Transformation Oleksandr Bornyakov oversees the growth of Diia.City.

Looking to clamp down, the Ukrainian employment service increased its fines for undeclared employees to 201,000 hryvnyas, or about $5,500, in March. Meanwhile, the Ministry of Digital Transformation launched Diia.City -- not an actual city but a new regime promising lower taxes and specialized legal protection for tech companies -- on February 15, nine days before the invasion.

Diia.City, which has brought in more than 500 member companies, seeks both to corral rogue local companies and woo foreign firms. The initiative splits the difference between the tax brackets for "contractors" and "employees" with a new category for gig workers. It also provides a publicly searchable register of "residents." Another selling point, for the time being: Protection from mobilization to fight on the front lines.

"A lot of people move companies to Diia.City, and people are shifting from private intrapreneurs to employees, so they can prevent them from going to the army," said Oleksandr "Alex" Bornyakov, deputy minister for digital finance and the manager of the Diia.City initiative.

With the hope for a new surge in investment both foreign and domestic, Lviv is positioning itself to be at the forefront of a new generation of tech-powered boomtowns.

According to the National Bank's most recent data, Lviv took in $2 billion in foreign direct investment in the last quarter of 2022, putting it third among Ukraine's cities, behind Kyiv and fossil-fuel-heavy Poltava.

The city is praying the situation is the countdown to a liftoff, despite the war and the global bear market in tech stocks. Fueling that prospective surge is more than a touch of defiance.

"Ukraine is booming, and will boom with you or without you, because we don't have another choice," Kozlova said.